Say-on-pay contests don’t affect many companies, but when they do happen, companies sometimes lose, and even a narrow win can lead to further complications.

To have the best chance of clear victory, it makes sense to ensure early on that the company’s compensation plans are defensible, that the surrounding governance is appropriate, and that vote-getting machinery is in place if needed.

Good idea, but not enough. Say-on-pay isn’t just about pay. Say-on-pay isn’t just about governance. Say-on-pay is usually about performance. More specifically, it is about investor dissatisfaction about performance.

AN ACTIVIST VULNERABILITY QUIZ

Ask your dozen largest shareholders these questions: • What is our long-term strategy? • How will that strategy create value for you? • How do you like the strategy? • How are we doing at executing the strategy?

This means that a large part of preventing a bad-odds say-on-pay fight is preventing, identifying and addressing investor dissatisfaction.

What’s needed here, even before a say-on-pay challenge surfaces, is a kind of old school investor relations expectation management. More on this in a moment. But first, how do you feel about executive compensation?

If a company’s stock is going through the roof, investors usually have no problem with management getting rich. Wall Street’s generally comfortable with the original hedge fund formula: “If I make money for you, I share in the profits. If I make nothing for you, I take nothing.”

If a company’s stock is performing in line with expectations, or if a company is executing well against a widely-understood and approved strategy, investors are usually content to see management paid well, in line with managements in general.

If the stock is lagging, if the performance is mediocre, and/or the strategy is unknown or unliked, investors will likely want management to get no more than a living wage (by C-suite standards), and to be shown the door if things don’t get better.

Say-on-pay contests happen most often in the third category. But the issue isn’t that the pay is too high. It’s that the pay is too high for the performance actually delivered. A company challenged on pay has to make a credible case for its compensation program. A company that wants to avoid being challenged on pay has to make a credible case for its performance. Both cases matter.

Before say-on-pay, an investor unhappy with a company’s performance had the choice between very small actions and very large actions.

Very small action was a letter, phone call or personal visit to management. Only the very largest shareholders really got management’s attention. Mere communication rarely affected corporate strategy or capital management.

Very large action was selling one’s investment. That erased the downside of future underperformance. It also erased the upside that persuaded investors to buy in the first place. And it didn’t send a clear message to management.

Very large action was also mounting a proxy fight to unseat board members. This was very expensive. It usually didn’t succeed. And even success wasn’t sure to send the stock upward. But the message to management was certainly clear.

Say-on-pay’s inclusion in Dodd-Frank gave shareholders a mid-size tool to show dissatisfaction – and to get management and board attention when they did. Effectively, say-on-pay is now a referendum on whether management earned its pay package – a referendum on performance. It requires nothing from investors or managements or boards. But it is a painfully visible statement of disapproval.

A company that loses a say-on-pay vote would be mad not to bring the pay package into line with investor acceptability. For those that don’t: The following year, activists now run withhold campaigns to unseat or discredit members of compensation committees who don’t respond to say-on-pay rejection.

The scorecard: There are more than 6000 public companies. Last year, 2,186 reported say-on-pay votes. Only 53 of those votes failed to get a majority in favor of the company’s comp program. Overall, about 90 percent of all votes cast anywhere were in favor of their company’s programs. Focus just on S&P 500: Out of 406 votes, only 12 got no majority for the company program.

Now add ISS to the mix. ISS, the proxy advisor, recommended against 278 comp plans (57 of the S&P). Of these, 176 got less that 70% of the vote. ISS (and some others) believe 70% is a better measure of shareholder acceptability than a 51% legal majority. ISS is reported to control or strongly influence up to 30% of all share voted.

ISS recommendations correlate pretty closely with activist-shareholder say-on-pay campaigns. ISS is more likely to take an interest if investors are vocally unhappy. Shareholders are more likely to go to war if the most prominent arbiter is on the case. So: Campaign + negative ISS = a worrisome chance of outright defeat, plus a pretty likely under-70% “publicity defeat.”

If a proxy fight begins, companies often complain that ISS has too much influence or a conflict of interest. Activists often complain that their target’s compensation plan doesn’t inflict enough financial pain when performance sours or the stock price tanks. Maybe true, maybe false, but neither argument is going to decide the outcome of the vote. The decisive issue is going to be: How do we, the shareholders, feel about the job our management is doing for us?

So let’s return to that thought from above: If a company’s stock is performing in line with expectations, or if a company is executing well against a widely-understood and approved strategy…. See the four questions in the box above. Almost without exception, companies that try this quiz are astonished at the degree of strategic misunderstanding and consequent dissatisfaction among the investors who should know them best.

Memo to management: Tell investors where you’re going. Tell them what’s in it for them. Give them some milestones that show you’re getting there. And, last but absolutely not least, ask them how they feel about your direction and your progress before they conclude they have to send you a message.

Sounds simple. Distressing how rarely it actually happens. Too many strategic statements are mush (does anyone not want to increase ROI?) Too many boards don’t consider how the strategies they approve create shareholder value. Too many companies do not connect their results to their strategies. And too many don’t ever really take their shareholders’ temperature.

We recommend that boards of directors reach a clear understanding about how they intend to create shareholder value. Sometimes this is explicitly communicated; sometimes not. Either way, it is the foundation for so much of the shareholder communications that follows, and therefore it needs to be reviewed and refreshed constantly. In our experience, this is uncommon.

We recommend that managements put forth strategic statements that specify goals, plans and rationales clearly enough for rational external analysis. In our experience, these statements are more common, but too often they’re so vague or legalistic that they fail their purpose.

We recommend that managements provide externally-visible milestones that show progress (or lack thereof) toward strategic goals. SEC-mandated data are pretty good about today; they’re not much help about tomorrow.

We recommend that corporate executives who speak to investors never stop imitating New York’s legendary mayor Ed Koch: Incessantly ask “How’m I doing?” If you ask and listen, you’ll have a better shot at avoiding a needless, expensive and disruptive battle over say-on-pay.”

Doing these things won’t eliminate the need to put together a say-on-pay fight team, just in case. Every year, we help a bunch of clients in say-on-pay fights, with good results. We’d rather help them implement these four steps – they might save the team from having to go into battle.